The coming challenge for defense.

Last month in this column, I speculated on the fiscal demands resulting from the Quadrennial Defense Review, and whether the plan is affordable. This month, we continue the focus on needs and resources, but begin to consider other factors that bear on the Defense Department's share of federal revenues.

The defense spending debate that continues to unfold in Washington, in many ways, ignores the harsh fiscal realities the nation will need to face.

As we observe ongoing war developments, defense strategy and budget trends, it is impossible to not notice that red flags are everywhere.

We have seen defense budgets grow consistently since 9/11. This was a necessary move to support expanding military commitments in Afghanistan and Iraq. But it is becoming increasingly clear that the spending will have to level off at some point, if the nation is to get its financial house in order.

At the same time, the United States will need to somehow find a way to keep its military forces from "breaking," as a result of repeated deployments, depleted stocks and worn-out equipment. And the Defense Department also must secure enough resources to modernize aging ground, sea and air weapons systems.

The Defense Department asked for $439.3 billion in fiscal year 2007. This is nearly a 7-percent increase over the budget that was enacted for 2006. Deputy Defense Secretary Gordon England points out that this may seem like a lot of money, but it represents a smaller percentage of the nation's gross domestic product than previous defense budgets. "This year's request is projected to be about 3.7 percent of GDP, but it was up to around 4.6 percent in 1991 during the Gulf War; 8.9 percent in 1968 during Vietnam; and 11.7 percent in 1953 at the height of our involvement in Korea," England noted at a House Budget Committee meeting.

England's analysis, however, leaves out one important ingredient in today's budget deliberations: the escalating amounts that are being added to the defense budget in the form of emergency war supplemental requests.

At the same Budget Committee hearing, Rep. Jim Ryun, R-Kan., said that since September 2001, the defense budget--including supplementals--has increased by about 70 percent--or by an average of about 11 percent per year. The nation has spent more than $383 and billion to fight the wars in Iraq Afghanistan. Assuming the president's most recent supplemental request of $68 billion is approved, Congress will have obligated more than $451 billion for these conflicts.

Ryun goes on to paint a rather bleak financial picture. "Even with our enormous entitlement programs--such as Medicaid, Medicare and Social Security--taken out of the equation, we have a limited pie from which we must fund not only defense, but homeland security and every other domestic program area ... And we've got a deficit we've got to reduce." Based on 2006 projections, by 2040 the entire U.S. federal budget barely will be enough to cover just Medicare and Social Security.

The question in the minds of many government and industry leaders is when and how much money will the Defense Department have to contribute toward fixing the deficit problem?

In anticipation of an eventual leveling off of resources, both the military services and defense industry have taken modest steps that are intended to cut costs and boost efficiency.

The Army is resisting a congressional push to permanently increase its ranks by 30,000 soldiers, and has decided to reorganize its 10 active divisions into 42 brigades, which would expand the number of units available to deploy without necessarily adding more people to the force. Adding to that, the 28 combat brigades planned for the Army National Guard, brings the total to 70 combat brigades eligible to be deployed. The Army also has launched a new troop-rotation system--the Army Force Generation Model--that theoretically would restrict deployments to one every three years for the active-duty force, and one every six years for the Reserves and National Guard.

Presently, many combat troops get to spend only 15 to 19 months back home before having to rotate back into combat.

Both the Navy and the Air Force are eliminating jobs, while simultaneously they are increasing the numbers of deployed sailors and airmen.

In the end, the services will have a greater percentage of "deployers," and fewer non-deployable administrative and support personnel.

Industry, for its part, remains on a path toward greater consolidation and vertical integration. Mergers, acquisitions and partnerships continue to be the order of the day. This is industry's response to the Pentagon's current buying pattern--the acquisition of fewer, more expensive items, underwritten by complex engineering and integration efforts. And while the unrelenting pace of industry consolidations may result in fewer domestic suppliers for the Defense Department, overseas firms increasingly participate and seek out opportunities in the largest defense market--all while the marketplace becomes more globalized.

Much anxiety is building about the outlook for defense, and that uncertainty is acutely felt in government and industry circles. When combat operations end and the supplemental dollars dry up, what will the financial "big bang" look like? With real pressures on the nation's resources, it does appear inevitable that tough choices will need to be made.

The final bit of pressure is the current state and projections for the federal budget. Looking at the tables for the 2006 budget (2007 tables not yet available), one sees that between 2004 and 2010, defense is projected to grow by 4.7 percent, the federal budget overall by 27 percent, healthcare by 39 percent, Medicare by 71 percent, income Security/Social Security by 21 percent and interest on the debt by 72 percent.

Given projected federal deficits, one can anticipate a big budget adjustment coming soon (no later than 2010-2015). Defense should expect to be a significant part of the adjustment. Earlier this month, Sen. Judd Gregg, R-N.H., chairman of the Budget Committee, said we are currently at a "critical juncture." Even though Congress strongly supports the war on terrorism, Gregg said, "We must also recognize that there is no such thing as an unlimited budget."

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